PERFORMANCE BOND AND AN INJUNCTION NUR AIN ISMAIL

PERFORMANCE BOND AND AN INJUNCTION NUR AIN ISMAIL A master s project report submitted in fulfillment of the requirements for the award of the degree of Master in Science of Construction Contract Management. Faculty of Built Environment Universiti Teknologi Malaysia July 2007

UNIVERSITI TEKNOLOGI MALAYSIA BORANG PENGESAHAN STATUS TESIS Psz 19:16 (pind. 1/97) JUDUL: PERFORMANCE BOND AND AN INJUNCTION SESI PENGAJIAN: 2006 / 2007 Saya NUR AIN ISMAIL (HURUF BESAR) Mengaku membenarkan tesis (PSM/ Sarjana/ Doktor Falsafah)* ini disimpan di Perpustakaan Universiti Teknologi Malaysia dengan syarat-syarat kegunaan seperti berikut: 1. Tesis adalah hakmilik Universiti Teknologi Malaysia 2. Perpustakaan Universiti Teknologi Malaysia dibenarkan membuat salinan untuk tujuan pengajian sahaja. 3. Perpustakaan dibenarkan membuat salinan tesis ini sebagai bahan pertukaran antara institusi tinggi. 4. ** Sila tandakan ( ) SULIT TERHAD (Mengandungi maklumat yang berdarjah keselamatan atau kepentingan Malaysia seperti yang termaktub di dalam AKTA RAHSIA RASMI 1972) (Mengandungi maklumat TERHAD yang telah ditentukan oleh organisasi/badan di mana penyelidikan dijalankan) TIDAK TERHAD Disahkan oleh (TANDATANGAN PENULIS) Alamat Tetap : No. 5, Lorong Sembilang 34, Seberang Jaya, 13700, Perai, Pulau Pinang. Tarikh : (TANDATANGAN PENYELIA) EN. JAMALUDDIN YAAKOB Nama Penyelia Tarikh : CATATAN: * Potong yang tidak berkenaan ** Jika tesis ini SULIT atau TERHAD, sila lampirkan surat daripada pihak berkuasa/ organisasi berkenaan dengan menyatakan sekali sebab dan tempoh tesis ini perlu dikelaskan sebagai SULIT atau TERHAD. Tesis dimaksudkan sebagai tesis bagi Ijazah Doktor Falsafah dan Sarjana secara penyelidikan, atau disertai bagi pengajian secara kerja kursus dan penyelidikan, atau Laporan Projek Sarjana Muda (PSM).

We hereby declare that we have read this project report and in our opinion this project report is sufficient in terms of scope and quality for the award of the degree of Master of Science in Construction Contract Management Signature Name of Supervisor I Date :.. ENCIK JAMALUDDIN YAAKOB :... :... Signature Name of Supervisor II Date :.. :... :...

DECLARATION I declare that this Master Project is the result of my own research and that all sources are acknowledged in the references. The project report has not been accepted for any degree and is not concurrently submitted in candidature of any other degree. Signature :... Name :... NUR AIN ISMAIL Date :...

To my family for their love and support

ACKNOWLEDGEMENTS With high gratitude to Allah S.W.T. who gave me the ideas and physical strength in preparing this master project. Along the master project completion, the author cannot efforts own selves without supporting and encouraging for the others parties. Because of that, I wish to express my thankful to the persons and all parties who involved in this research and offered a valuables cooperation in carrying out this final project. First of all, I would give my acknowledgement to my supervisor En Jamaluddin Yaakob for his guidance, support and giving the ideas in preparing of this master project. My appreciation also goes to all the lecturers for the course of Master of Science in Construction Contract Management, for their patient and kind advice during the process of completing the master project. I am also thankful to my parents for their helpfulness and encouragement while preparing this master project. Lastly, I would like to thank my classmates for giving me morale support and supplying me with the information on how to write a master project. Thank you for all participants whose have give a lot of uproot that I really need in completing the master project.

TABLE OF CONTENTS PAGE TITLE DECLARATION DEDICATION ACKNOWLEDGEMENT ABSTRACT ABSTRAK TABLE OF CONTENTS LIST OF CASES LIST OF ABBREVIATIONS LIST OF FIGURES / TABLES i ii iii iv v vi vii ix xiii xiv CHAPTER 1 INTRODUCTION 1.1 Background of Topic 1 1.2 Problem Statement 4 1.3 Objective of Topic 6 1.4 Scope of Topic 6 1.5 Significant of Topic 7 1.6 Methodology and Research Process 7 1.7 Terminology 12

PAGE CHAPTER 2 PERFORMANCE BOND 2.1 Introduction 14 2.2 Surety Bond in Construction Contracts 15 2.3 Performance Bond 16 2.3.1 Performance Bond and Letter of Credit 20 2.4 Types of Performance Bond 22 2.4.1 Conditional Bonds 25 2.4.2 Unconditional Bonds 27 2.4.3 Difference between conditional and unconditional performance bonds 28 2.5 Nature of Performance Bonds 29 2.5.1 Construction of the Performance Bond 30 2.6 Calling the Bonds 31 2.6.1 Calling on an unconditional bond 31 2.6.2 Calling on a conditional bond 33 2.7 Grounds of Discharged in Performance Bond 33 2.8 Summary 35 2.9 Flowchart on Performance Bond Procedure 36

PAGE CHAPTER 3 INJUNCTION RELIEF TO RESTRAIN PAYMENT OF PERFORMANCE BOND 3.1 Introduction 40 3.2 Injunction Relief in Civil Procedure 42 3.2.1 Types of Injunction Relief in Civil Procedure 43 3.2.2 Distinction between Interim Injunction and Interlocutory Injunction. 45 3.2.3 Statutory provision 45 3.2.4 Application of Injunction 46 3.2.5 When injunction cannot be granted 47 3.3 Circumstances to Issue Injunctive Relief for restraining payment of Performance Bond. 48 3.3.1 Injunction to restrain the surety 49 3.3.2 Injunction to restrain a beneficiary 55 3.3.3 Injunction to restrain a beneficiary from making claim 55 3.3.4 Mareva injunction to freeze a call 58 3.4 Summary 59

PAGE CHAPTER 4 LEGAL PRINCIPLES IN PERFORMANCE BOND ON APPLICATION OF INJUNCTION TO RESTRAIN A CALL OR DEMAND OF THE BOND 4.1 Introduction. 64 4.2 Legal Interpretation on application of Injunction in Performance Bond. 65 4.2.1 Principal of granting the injunction in Performance Bond 66 4.2.2 Fraudulent or Unconscionable conduct in Performance Bond. 67 4.2.3 Principal in American Cyanamid Co. v Ethicon Ltd 75 4.2.4 Balance of Convenience. 77 4.2.5 Bone fide Serious Issues to be tried. 79 4.2.6 Remedies in damages are adequate 95 4.3 Summary of Findings 96 CHAPTER 5 CONCLUSION AND RECOMMENDATIONS 5.1 Introduction 106 5.2 Conclusion 108 5.3 Recommendation 110 REFERENCES 111 BIBLIOGRAPHY 116

LIST OF CASES CASES PAGE Alor Janggus Soon Seng Trading Sdn Bhd & Ors v Sey Hoe Sdn Bhd & Ors [1995] 1 MLJ 241...78 American Cyanamid Co. v. Ethicon Ltd [1975] AC 396 3, 66, 74 Bains Harding (Malaysia) Sdn. Bhd. v. Arab-Malaysian Merchant Bank Bhd & Ors [1996] 1 MLJ 425 79 Bocotra Construction Pte Ltd v. Attorney General (No 2) [1995] 2 SLR 733...31, 55, 65, 67, 83 Bolivinter Royal SA v. Chase Manhattan Bank [1984] 1 Lloyds' Law Rep 251. 30, 51, 69, 92 Bollore Furniture Ltd v. BNP [1983] HKLR 78..30 Brody White & Co. v Chemet Handel Trading (S) Pte Ltd [1993] 1 SLR 65.76 Cargill International v. Siporex Trade [1998] 1 WLR 461.28 Cayne v Global Natural Resources plc [1984] 1 All ER 225.76 China Airlines Ltd v. Maltan Air Corp Sdn Bhd [1996] 2 MLJ 517...22 CSR Ltd v. Cigna Insurance Australia Ltd [1997] 189 CLR 345 at 390.42 C.D.N. Research and development Ltd. v. Bank of Nova Scotia and Others, C.D.N. Research and development Ltd. v. Bank of Nova Scotia and Others [1982] 136 DLR 3d 656..52 Dauphin Offshore Engineering & Trading Pte Ltd [2000] 1 SLR 657 71 Daewoo Engineering & Construction Co. Ltd v. The Titular Roman Catholic Archibishop of Kuala Lumpur [2004] 7 MLJ 136..85 Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978] QB 159....20, 28, 39, 51, 53, 64, 66, 68 Elian and Rabbath v. Matsas and Matsas [1966] 2 Lloyd s Rep 495 50 Esal (Commodities) Ltd v. Oriental Credit Ltd [1985] 2 Lloyd's Rep 546...24, 28, 50

Esso Petroleum Malaysia Inc. v. Kago Petroleum Sdn. Bhd. [1995] 1 MLJ 149..3, 16, 23, 53, 67, 83 Fellowes & Son v Fisher [1976] QB 122.75 Films Rover International Ltd v Cannon Film Sales Ltd [1987] 1 WLR 672.76 Four Seas Construction Pte Ltd v The Tai Ping Insurance Co Limited [1998] SGHC 414 71 Francome v Mirror Group Newspapers Ltd [1948] 2 All ER 408..76 GHL Pte Ltd v Unitrack Building Construction Pte Ltd [1999] 4 SLR 604. 71, 73 GKN Contractors Ltd v Lloyds Bank (1986) 30 BLR 53...40, 51, 52, 68 Gulf Bank KSC v. Mitsubishi Heavy Industries (No.2) [1994] 2 Lloyd;s Rep 145..28 Hamzeh Malas & Sons v British Imex Industries Ltd [1958] 2 QB 127.93 Hemis Interco BV Sdn Bhd v Syarikat Pembenaan Hashbudin (M) Sdn Bhd [1986] 1 MLJ 245...81 Hong Kong Teakwood Ltd v. Hyundai Engineering & Construction Co. Ltd. [1987] 2 MLJ 575...87 Hortico (Australia) Pty Ltd v. Energy Equipment Co (Australia) Pty Ltd [1986] 2 BCL 366...30 Howe Richardson Scale v. Polimex-Cekop [1978] Lloyd s Rep 161... 28, 49, 64 HSH Engineering & Construction Sdn. Bhd. v. Belton Properties Sdn. Bhd. & Anor [2001] MLJU 85...80 Hughes Bros Ltd v. Telede [1991] 7 BCL 210.30 IJM Construction Sdn. Bhd. v. Cleveland Development Sdn. Bhd. [2001] MLJU 99..81 Intraco Ltd. v. Notis Shipping Corporation (The Bhoja Trader) [1981] 2 Lloyd s Rep 25 57, 64 Isyoda (M) Sdn Bhd v. Mimos Bhd [2000] 1 MLJ 225...84 Jasa Keramat Sdn. Bhd. & Anor v. Monatech (M) Sdn. Bhd. [1999] 4 MLJ 637... 48 Keet Gerald Francis Noel John v. Mohd Noor @ Harun b. Abdullah & Ors. [1995] 2 AMR 1859 77 Kerajaan Malaysia v. South East Asia Insurance Bhd. [2000] 3 CLJ 711. 30 Kirames Sdn. Bhd. v. Federal Land Development Authority [1991] 2 MLJ 198..91

Knaerver Singapore Pte v. UDL Shipbuilding (Singapore) Pte Ltd. [1993] 3 SLR 350..53, 83 Korea Industry Co Ltd v Andoll Ltd [1989] 3 MLJ 449..66 I.E Contractors Ltd. v. Lloyd s Bank Plc and Rafidain Bank [1990] 2 Lloyd s Rep 496...30 LEC Contractors (M) Sdn. Bhd. V. Castle Inn Sdn. Bhd. [2000] 3 MLJ 339 2 Liang Huat Aluminium Industries Pte Ltd v. Hi-Tek Construction Pte Ltd. [2001] SGHC 334 74 Malaysia Overseas Investment Corporation Sdn Bhd v. Sri Segambut Supermarket [1986] 2 MLJ 382.23 Mareva Cia Naviera SA v. International Bulk Carriers SA Sdn Bhd [1980] 1 All ER 213...56 Min Thai Holdings Pte Ltd v Sunlabel & Anor [1999] 2 SLR 368...70 New Civilbuild Pte Ltd v Guobena Sdn Bhd & Anor [1999] 1 SLR 374.72 Newtech Engineering Construction Pte Ltd v. BKB Engineering Constructions Pte Ltd & Others. [2003] SGHC 141; [2003] 4 SLR 73...69 Ninemia Maritime Corpn. Trave Schiffahrtgessellschaft mbh, KG, The Niedersachen [1983] 1 WLR 1412.57 Olex Focas Pty Ltd v. Skodaexport Co Ltd [1996] 134 FLR 331..31, 67 Patel Holdings Sdn. Bhd. V. Estet Pekebun Kecil & Anors [1989] 1 MLJ 190 HC..19, 23, 91 PDE Consulting Services Sdn Bhd v. Chuan Cement Industries (M) Sdn Bhd, [2002] MLJU 681 82 Pembinaan Maluri Sdn Bhd v. Prudential Assurance Sdn Bhd [1991] 2 MLJ 350....24 Pekeliling Triangle Sdn Bhd v. Chase Perdana Berhad. [2002] MLJU 511...89 Perar v. General Surety and Guarantee [1994] 66 BLR 72. 28 Perkasa Duta Sdn. Bhd. v Perbadanan Kemajuan Negeri Selangor [2002] 2 CLJ 307...67 Royal Design Studio Pte Ltd. v. Chang Developments Pte Ltd [1991] 2 MLJ 229 55, 83

R. D. Harbottle (Merchantile) Ltd. v. National Westminster Bank Ltd. [1978] 1 QB 146.48, 51, 64, 68 Samwoh Asphalt Premix Pte Ltd v Sum Cheong Piling Pte Ltd. [2002] 1 SLR 1...71 Sari Artists Film Production Sdn. Bhd. v. Malaysia Film Industries Sdn. Bhd [1974] 1 MLJ 123, HC....41 Siemens Integra Transportation System Sdn Bhd & Anor v. EKD Construction Sdn Bhd & Anor [2003] MLJU 475...3, 69 Siskina (Cargo Owners) v. Distois Compania Naviera SA [1979] AC 210...47, 57 Teknik Cekap Sdn, Bhd v Public Bank Bhd [1995] 3 MLJ 449... 15, 24 Ten Engineering Sdn Bhd v. Resort Villa Development Sdn Bhd & Anor [2002] MLJU 734 85 The Brightside Mechanical And Electrical Services Group Ltd & Anor v. Standard Chartered Bank & Anor. [1989] 3 MLJ 13..88 Themehelp Ltd. v. West [1995] 4 All ER 215..54 Third Chandris Shipping Corporation. v. Unimarine SA [1979] QB 645...57 Tins Industrial Co Ltd v. Kono Insurance Ltd [1987] 42 BLR 110 32 United Trading Corp. S.A and Murray Clayton Ltd. v. Allied Arab Bank Ltd & Others [1985] 2 Lloyd s Rep. 554.. 20, 40, 48, 49, 52, 66, 68 Veracruz Transportation Inc. v. V C Shipping Co. Inc. and Den Norske Bank A/S, The Veracruz [1992] 1 Lloyd s Rep. 353 57 Z Ltd. v. A-Z [1982] 2 WLR 288..57

LIST OF ABBREVIATIONS AC All ER AMR App Cas Build LR CLJ EWCA Civ HL Lloyd s Rep LR MLJ PC QB SCR SLR WLR Law Reports: Appeal Cases All England Law Reports All Malaysia Reports Appeal Cases Building Law Reports Current Law Journal (Malaysia) Court of Appeal, Civil Division (England & Wales) House of Lords Lloyd s List Reports Law Reports Malayan Law Journal Privy Council Queen Bench Session Cases Report Singapore Law Report Weekly Law Report

LIST OF FIGURES / TABLES PAGE Chart 1.1: Flow Chart of Methodology..11 Table 2.1: Examples of wording in Unconditional Bond and On demand Bond..24 Figure 2.1: Flowchart on Performance Bond Procedural Requirement (Part I)..36 Figure 2.2: Flowchart on Performance Bond Procedural Requirement (Part II).37 Figure 2.3: Flowchart on Procedure Following Failure to Submit Bond or Guarantee..38

CHAPTER 1

CHAPTER 1 INTRODUCTION 1.1 Background of Topic Claims under performance bonds or guarantees are frequently the subject of litigation in Malaysia. 168 This is due to the fact that in most of the local standard forms of building contract, the performance bond and / or bank guarantee being one of the mandatory conditions upon the award of the contract. 169 Performance bond and guarantees are intended to provide assurance to the owner of a project that the project will be completed. 170 Regardless of the reason, if the main contractor fails to fulfill its contractual obligations, the owner, and those referred as insured or obligee, is protected by the surety against loss up to the amount of bond penalty. 171 Beside that, there are two significant benefits of performance bond i.e. the 168 Powell-Smith, V. (1992). Calls on Performance Bond in Malaysia-The Current Law. The Malayan Law Journal Articles. Vol. 2. 169 Ho Sook Chin, To Have and To Hold: Performance Bonds and Bank Guarantees, Available in Construction News & Views, The Quarterly Newsletter of JUBM & DLS, Issue 1 June 2006 170 How the owner derives benefit from a performance bond. Published date on July 05, 2000. Available in http://www.reedsmith.com. 171 Bockrath, J. T. (2000). Contracts and Legal Environment for Engineers & Architects. 6 th Edition. United State: McGraw Hill Companies, Inc.

third party legal promise of strong financial standing and the right to immediate and unconditional payment where the payment obligation almost as good as cash. 172 In the current state of the construction industry, performance bonds are here to stay, but there are possible pitfalls when the time comes to call on the bond. The call on the bond as set out in that bond itself with order to be entitled for payment. 173 If the parties in dispute, before the dispute resolved, whether or not the prime contractor has performed its obligations under the contract and the client makes a call off the bonds. 174 A demand or call for payment under performance bond is almost predictable with preceeding for injunction relief 175 if there are any protests or any contestation from contractor or subcontractor to refrain the employer or contractor from gaining the benefits in performance bond. In case of LEC Contractors (M) Sdn. Bhd. V. Castle Inn Sdn. Bhd. 176 the wordings of the bond herein this case read as follow: If the Contractor (unless relieved from the performance by any clause of the Contract or by statute or by the decision of a tribunal of competent jurisdiction) shall in any respect fail to execute the Contract or commit any breach of his obligations thereunder then the Guarantor shall pay to the Principal up to and not exceeding the sum of Ringgit Malaysia: Four Million Eight Hundred Thousand only (RM4.8,) representing 5% of the Contract value or such part thereof, on the Principal s written demand notwithstanding any contestation or protest by the Contractor or by the Guarantor or by any other third party. 177 172 Low Kee Yang, (2003) The Law of Guarantees in Singapore & Malaysia, 2 nd Edition, Singapore: LexisNexis Butterworth. 173 Micheal Teoh, Understanding Bonds and Guarantee Provisions in Construction Contracts in Construction Contract Conference on 29-30 th September 2003 at Kuala Lumpur. 174 Ibid, Footnote 2. 175 Ibid, Footnote 6. 176 [2000] 3 MLJ 339 177 At page 347 of the judgment.

From the stated case above, a party may seek to injunctive relief when there are legal suit to be brought forward to the court. 178 The subject to injunctive relief on performance bond is a complex and controversial one. This is because, injunction in performance bond occurred wherein surety party in arrangement of bond calling and acquired injunction order from the main purpose is to withhold the payment of performance bond to beneficiary. 179 Different approaches have been used by the courts to lessen the severe impact in any of misjudged cases. 180 By examining the principal s perspective and the call had been made by the beneficiary, the court will provide clarification on whether to award injunction or not. A court will grant the relief if the party able to convince that without the relief there will be irretrievable damages due to inadequate compensation. 181 Beside that, the injunction will be given if it is in exceptional circumstances where the courts will interfere with the machinery of irrevocable obligations assumed by banks. 182 Fraud has been ruled to be an instance of such exceptional circumstances. 183 178 The issues will depend on the facts of the case; the construction of the performance bond and the contract. See in Esso Petroleum Malaysia Inc. v. Kago Petroleum Sdn. Bhd. [1995] 1 MLJ 149 and American Cyanamid Co. v. Ethicon Ltd [1975] AC 396 179 Abdul Aziz Hussin & Abdul Rashid Abdul Aziz. (2001). Undang-undang Pembinaan: Bon-bon Gerenti dalam Kontrak Pembinaan. Pulau Pinang: Penerbit Universitti Sains Malaysia. 180 Ibid, Footnote 5. 181 Dixon. W. M. (2004) As good cash? The Diminution of the Autonomy Principle. Australian Business Law Review. 32(6): pp. 391-406. Acessed from http://eprints.qut.edu.au. 182 Siemens Integra Transportation System Sdn Bhd & Anor v. EKD Construction Sdn Bhd & Anor[2003] MLJU 475 183 See Esso Petroleum Malaysia Inc. v Kargo Petroleum Sdn. Bhd. [1995] 1 MLJ 149.

1.2 Problem Statement As discussed above, it shows how importance for having bonds and guarantee in construction contract. The purpose of holding a performance bond is to provide assurance that in the event of insolvency of, or default by, the contractor during the construction, the employer may secure payment or compensation from the solvent (and substantial) paymaster. Hence it is sometimes called performance security. It is obvious that any performance bond worth having should be in the form of an irrevocable unconditional (or on-demand) bank guarantee, on the premise that such instrument is as good as cash in hand. 184 However, performance bond or performance guarantee has been the subject of considerable litigation in recent years from any jurisdictions and in Malaysia. Several issues 185 arise within the disputed cases are as follows: (1) whether an instrument is a conditional or an on-demand bond; (2) the effect of failure on the part of the beneficiary to give notices; (3) availability of an injunction to restrain the surety from paying after a call has been made by the beneficiary; (4) availability of an injunction to restrain a beneficiary from receiving payment after a demand has been made; (5) availability of an injunction to restrain a beneficiary from making claim; (6) availability of a Mareva injunction to freeze a call; (7) meanings of certain phrases used in the instruments; and (8) a duty to account for proceeds of a call. Out of four from the stated issues above, indicates that injunction is the considerable issue in determining any relationship with the performance bond. 184 Ibid, Footnote 2. 185 Issaka Ndekugri. (1999). Performance Bonds and Guarantees: Construction Owners and Professionals Beware. Journal of Construction Engineering And Management. 125(6): 428-436

These issues arose because the possession of knowledge of the issues and principle should enable the construction and engineering industries and their legal advisers to better prioritize on which matter require extra attention in the drafting and negotiation of these instruments. Therefore, non-ambiguous legal principles should also contribute to reduction in litigation. 186 In recent years, surety companies, contractors, and owners have struggled over the definition of the rights and liabilities flowing from performance bonds and every construction industry participants are advised to develop sufficient basic understanding of the rights and potential liabilities associated with the performance bond. 187 Under such circumstances, an understanding of the legal principles involved is crucial. The discussions highlighted on the situation where the injunction applied by the party which have the equity interest on performance bond. Injunction arose when an improper conduct by a beneficiary of an on-demand performance bond i.e., calling the bond when there has been no breach or when he himself in breach of the underlying contract is apparent. For reasons of simplicity, on-demand performance bonds are hereafter referred to as performance bonds. The issuer is assumed to be a bank for the same reasons and the fact that it is the most common practice. It is also to be noted that in some of the cases to be referred to, although the judgments referred to performance guarantees, the instruments involved were performance bonds. 188 Since the injunction have given significant impact to the purpose of performance as a financial security to beneficiary, these question drag various inquiries such as; Whether the injunction is the best way to restrain the beneficiary to gain the benefits where there is existence of default from beneficiary or principal itself? Will the performance bond s privilege being challenge by applying the injunction relief from the 186 Ibid, Footnote 18. 187 Smith, Currie & Hancock LLP s, (2001), Common Sense Construction Law, A Practical Guide for the Construction Professional, New York: John Wiley & Sons, Inc. 188 Ibid, Footnote 18.

court? And it is very vital to know how the legal interpret the principles of injunction granting in the performance bond? Thus, the above-mentioned questions are useful as the foundation of this research in searching the most relevant answers to those questions. Hence it is important and necessary for understanding the circumstances in performance bond, which will be available to the parties to a building contract. And from that, parties involved will clearly defined their rights and liability against bonds and guarantee to assist the respective party in construction contract. 1.3 Objective of Topic The objective of the study is to identify legal principles used by the courts in granting or rejecting an application for injunction against bondsmen from making payment or against employer from receiving the bonds. The objective of the topic is spelt out through the analysis made on the common issues disputed throughout problem statement above. 1.4 Scope of Topic The examination is based on cases related to building contract and any circumstances arising thereof, in connection to the building contract. Beside that, the cases selected which decided from by Malaysian courts. However, there are frills with relevant cases from other jurisdiction.

1.5 Significance of Topic This study is hoped to give brief information on the bond application, management and its effectiveness in construction contract practice in order to be a reference to the Malaysian construction contract practice. Once they understand the basic principles, and realize their rights and liabilities in performance bond when the time of calling or receiving payment, the potential dispute might reduce. Beside that, it is significant if this study could identify the problems and recurring issues in court cases regarding bonds and guarantees in injunction relief to restrain the payment of bond and determining the principles involved in the court judgment. 1.6 Methodology and Research Process In order to fulfill all the objectives of this topic, the method that need to be taken had been recognized and planned. All methods have been divided into stages as assessment of this research as shown in Chart 1.1. Beside that, the research process on this report generally consists of four (4) stages, i.e. 1 st stage: Analysis of the problem, 2 nd stage: Identification of issues commonly in dispute, 3 rd stage: Finding of primary sources of relevant law and 4 th stage: In-depth examination of the individual cases to extract the relevant legal principles. 1.6.1 Problem Analysis As a necessary precondition, the basic concepts relevant to the study had to be understood. This understanding was acquired from textbooks, journals or any printed

sources. The subject of guarantees and bonds is still very specialized. Good understandings of the basic concepts to be used to refer to specific aspects were examined. The terms available in such as contract, guarantee, bond, performance guarantees, performance bond, security, performance security, banking, suretyship, and construction law. The information and data of this research will be obtained and collected from the analysis. Mostly the research will exercise the resources from two (2) basic types of sources. There are: 1.6.1.1 Primary Data Primary data collected mainly from Malayan Law Journal, Singapore Law Report, Building Law Report, Construction Law Report and other law journals. It is collected through the LexisNexis law database. All the cases relating to the research topic will be collected in order to identify the problems and the recurring issues related to bonds and guarantees in Malaysia and overseas construction contracts. 1.6.1.2. Secondary data Secondary research data will be retrieved from the books, standard form of building contract, articles and journals, seminars papers as well as Internet websites. These sources are important to complete the literature review chapter.

All the data that have been obtained will be systematically analyzed, interpreted, arranged and write up. 1.6.2 Identification of Disputed Issues The present stage was essentially a formalization of the issue identification process through references to relevant law reports and articles in journals. The use of indexes of legal journals and law reports ensured the identification of every relevant case and article. The issues most commonly raised in litigation have two main sources. The first concerns the interpretation of the particular instrument, i.e., the nature and extent of the obligations undertaken by the bondsman or surety, whereas the second is about the circumstances in which a court may restrain a claim on the instrument or dealing with the proceeds of a successful claim. 1.6.3 Identification of Relevant Case Law The outcome of the earlier stages was identification of the relevant questions and the establishment of trails of the law on each issue in the form of some relevant cases. Citatory were used to identify subsequent cases in which each case already identified was affirmed, applied, approved, considered, disapproved, distinguished, doubted, explained, extended, followed, not followed, overruled, referred to, or reversed.

1.6.4 In-depth examination of the individual cases to extract the relevant legal principles. Then, each case examined to extract the relevant legal principles accordance to the objective of this report. It mainly involves analyzing and writing.

PRELIMINARY RESEARCH RESEARCH PROPOSAL FINAL DRAFT OF RESEARCH PROPOSAL PRELIMINARY DISCUSSION WITH SUPERVISOR LIBRARY AND PUBLISHED Or printed articles IDENTIFIED RELATED CASES INTENSIVE DISCUSSION WITH SUPERVISOR DATA GATHERING PRIMARY DATA Legal cases from website SECONDARY DATA books, journal, magazines, or other ANALYSIS OF DATA WRITING OF FINDINGS CONCLUSION & RECOMMENDATION Chart 1.1. Flow Chart of Methodology

1.7 Terminology The following terms used frequently in this project report. Therefore, to preventing any misunderstanding and give benefit to non-legal readers, terminology is helping. 1.7.1 Surety 189 Webster s Dictionary defines surety as, The state of being sure; A pledge or other formal engagement given for the fulfillment of an undertaking; the one who has become legally liable for the debt, default, or failure in duty of another. The Surety Association of America (SAA) has defined a surety bond as, An agreement providing for monetary compensation should there be a failure to perform specified acts within a stated period. 1.7.2 Guarantees 190 A guarantee has been defined as an accessory contract by which the promisor (the guarantor) undertakes to be answerable to the promisee (the creditor) for the debt, default, or miscarriage of another person (the debtor), whose primary liability must exist or be contemplated (Halsbury s 1993). 189 Roozbeh Kangari. & Moataz Bakheet. (2001). Construction Surety Bonding. Journal Of Construction Engineering And Management. 127(3): 232-238 190 Ibid, Footnote 18.

1.7.3 Bonds 191 A bond is a promise by deed by one party to pay another a sum of money. A guarantee executed as a deed in which the guarantor undertakes to answer for the debt, default, or miscarriage of another by a monetary payment is therefore a bond. The bond may make payment unconditional, i.e., payment must be made on a demand by the promise or it could be conditional on defined events. The former type are referred to as a first conditional bond or an on demand bond, whereas the latter type is called a conditional bond. In practice, a conditional bond is commonly referred to as a guarantee or performance guarantee, whereas the terms performance bond or even just bond is reversed for unconditional bonds. 1.7.4 Synonymous Title of Parties Involved 192 1. Guarantor, Surety, Bondsman, Obligor, (and in the case of some on demand or letter of credit situations Bank or Issuing bank. 2. (principal) Creditor, Obligee, and, in some on demand situations, Beneficiary (who in the case of performance as opposed to payment bonds will normally be the construction owner, or in the case of some subcontracts the employing main contractor). 3. (principal) Debtor, Principal, that is, the party whose obligation is guarantees, in performance bond, this will be the contractor or subcontractor. 191 Ibid, Footnote 18. 192 Wallace, I.N.D. (1995). Hudson s Building and Engineering Contracts: Including the Duties and Liabilites of Architects, Engineers and Surveyors. 11 th Edition. Vol. 2. London: Sweet & Maxwell Limited.

CHAPTER 1

CHAPTER 1 INTRODUCTION 1.1 Background of Topic Claims under performance bonds or guarantees are frequently the subject of litigation in Malaysia. 168 This is due to the fact that in most of the local standard forms of building contract, the performance bond and / or bank guarantee being one of the mandatory conditions upon the award of the contract. 169 Performance bond and guarantees are intended to provide assurance to the owner of a project that the project will be completed. 170 Regardless of the reason, if the main contractor fails to fulfill its contractual obligations, the owner, and those referred as insured or obligee, is protected by the surety against loss up to the amount of bond penalty. 171 Beside that, there are two significant benefits of performance bond i.e. the 168 Powell-Smith, V. (1992). Calls on Performance Bond in Malaysia-The Current Law. The Malayan Law Journal Articles. Vol. 2. 169 Ho Sook Chin, To Have and To Hold: Performance Bonds and Bank Guarantees, Available in Construction News & Views, The Quarterly Newsletter of JUBM & DLS, Issue 1 June 2006 170 How the owner derives benefit from a performance bond. Published date on July 05, 2000. Available in http://www.reedsmith.com. 171 Bockrath, J. T. (2000). Contracts and Legal Environment for Engineers & Architects. 6 th Edition. United State: McGraw Hill Companies, Inc.

third party legal promise of strong financial standing and the right to immediate and unconditional payment where the payment obligation almost as good as cash. 172 In the current state of the construction industry, performance bonds are here to stay, but there are possible pitfalls when the time comes to call on the bond. The call on the bond as set out in that bond itself with order to be entitled for payment. 173 If the parties in dispute, before the dispute resolved, whether or not the prime contractor has performed its obligations under the contract and the client makes a call off the bonds. 174 A demand or call for payment under performance bond is almost predictable with preceeding for injunction relief 175 if there are any protests or any contestation from contractor or subcontractor to refrain the employer or contractor from gaining the benefits in performance bond. In case of LEC Contractors (M) Sdn. Bhd. V. Castle Inn Sdn. Bhd. 176 the wordings of the bond herein this case read as follow: If the Contractor (unless relieved from the performance by any clause of the Contract or by statute or by the decision of a tribunal of competent jurisdiction) shall in any respect fail to execute the Contract or commit any breach of his obligations thereunder then the Guarantor shall pay to the Principal up to and not exceeding the sum of Ringgit Malaysia: Four Million Eight Hundred Thousand only (RM4.8,) representing 5% of the Contract value or such part thereof, on the Principal s written demand notwithstanding any contestation or protest by the Contractor or by the Guarantor or by any other third party. 177 172 Low Kee Yang, (2003) The Law of Guarantees in Singapore & Malaysia, 2 nd Edition, Singapore: LexisNexis Butterworth. 173 Micheal Teoh, Understanding Bonds and Guarantee Provisions in Construction Contracts in Construction Contract Conference on 29-30 th September 2003 at Kuala Lumpur. 174 Ibid, Footnote 2. 175 Ibid, Footnote 6. 176 [2000] 3 MLJ 339 177 At page 347 of the judgment.

From the stated case above, a party may seek to injunctive relief when there are legal suit to be brought forward to the court. 178 The subject to injunctive relief on performance bond is a complex and controversial one. This is because, injunction in performance bond occurred wherein surety party in arrangement of bond calling and acquired injunction order from the main purpose is to withhold the payment of performance bond to beneficiary. 179 Different approaches have been used by the courts to lessen the severe impact in any of misjudged cases. 180 By examining the principal s perspective and the call had been made by the beneficiary, the court will provide clarification on whether to award injunction or not. A court will grant the relief if the party able to convince that without the relief there will be irretrievable damages due to inadequate compensation. 181 Beside that, the injunction will be given if it is in exceptional circumstances where the courts will interfere with the machinery of irrevocable obligations assumed by banks. 182 Fraud has been ruled to be an instance of such exceptional circumstances. 183 178 The issues will depend on the facts of the case; the construction of the performance bond and the contract. See in Esso Petroleum Malaysia Inc. v. Kago Petroleum Sdn. Bhd. [1995] 1 MLJ 149 and American Cyanamid Co. v. Ethicon Ltd [1975] AC 396 179 Abdul Aziz Hussin & Abdul Rashid Abdul Aziz. (2001). Undang-undang Pembinaan: Bon-bon Gerenti dalam Kontrak Pembinaan. Pulau Pinang: Penerbit Universitti Sains Malaysia. 180 Ibid, Footnote 5. 181 Dixon. W. M. (2004) As good cash? The Diminution of the Autonomy Principle. Australian Business Law Review. 32(6): pp. 391-406. Acessed from http://eprints.qut.edu.au. 182 Siemens Integra Transportation System Sdn Bhd & Anor v. EKD Construction Sdn Bhd & Anor[2003] MLJU 475 183 See Esso Petroleum Malaysia Inc. v Kargo Petroleum Sdn. Bhd. [1995] 1 MLJ 149.

1.2 Problem Statement As discussed above, it shows how importance for having bonds and guarantee in construction contract. The purpose of holding a performance bond is to provide assurance that in the event of insolvency of, or default by, the contractor during the construction, the employer may secure payment or compensation from the solvent (and substantial) paymaster. Hence it is sometimes called performance security. It is obvious that any performance bond worth having should be in the form of an irrevocable unconditional (or on-demand) bank guarantee, on the premise that such instrument is as good as cash in hand. 184 However, performance bond or performance guarantee has been the subject of considerable litigation in recent years from any jurisdictions and in Malaysia. Several issues 185 arise within the disputed cases are as follows: (1) whether an instrument is a conditional or an on-demand bond; (2) the effect of failure on the part of the beneficiary to give notices; (3) availability of an injunction to restrain the surety from paying after a call has been made by the beneficiary; (4) availability of an injunction to restrain a beneficiary from receiving payment after a demand has been made; (5) availability of an injunction to restrain a beneficiary from making claim; (6) availability of a Mareva injunction to freeze a call; (7) meanings of certain phrases used in the instruments; and (8) a duty to account for proceeds of a call. Out of four from the stated issues above, indicates that injunction is the considerable issue in determining any relationship with the performance bond. 184 Ibid, Footnote 2. 185 Issaka Ndekugri. (1999). Performance Bonds and Guarantees: Construction Owners and Professionals Beware. Journal of Construction Engineering And Management. 125(6): 428-436

These issues arose because the possession of knowledge of the issues and principle should enable the construction and engineering industries and their legal advisers to better prioritize on which matter require extra attention in the drafting and negotiation of these instruments. Therefore, non-ambiguous legal principles should also contribute to reduction in litigation. 186 In recent years, surety companies, contractors, and owners have struggled over the definition of the rights and liabilities flowing from performance bonds and every construction industry participants are advised to develop sufficient basic understanding of the rights and potential liabilities associated with the performance bond. 187 Under such circumstances, an understanding of the legal principles involved is crucial. The discussions highlighted on the situation where the injunction applied by the party which have the equity interest on performance bond. Injunction arose when an improper conduct by a beneficiary of an on-demand performance bond i.e., calling the bond when there has been no breach or when he himself in breach of the underlying contract is apparent. For reasons of simplicity, on-demand performance bonds are hereafter referred to as performance bonds. The issuer is assumed to be a bank for the same reasons and the fact that it is the most common practice. It is also to be noted that in some of the cases to be referred to, although the judgments referred to performance guarantees, the instruments involved were performance bonds. 188 Since the injunction have given significant impact to the purpose of performance as a financial security to beneficiary, these question drag various inquiries such as; Whether the injunction is the best way to restrain the beneficiary to gain the benefits where there is existence of default from beneficiary or principal itself? Will the performance bond s privilege being challenge by applying the injunction relief from the 186 Ibid, Footnote 18. 187 Smith, Currie & Hancock LLP s, (2001), Common Sense Construction Law, A Practical Guide for the Construction Professional, New York: John Wiley & Sons, Inc. 188 Ibid, Footnote 18.

court? And it is very vital to know how the legal interpret the principles of injunction granting in the performance bond? Thus, the above-mentioned questions are useful as the foundation of this research in searching the most relevant answers to those questions. Hence it is important and necessary for understanding the circumstances in performance bond, which will be available to the parties to a building contract. And from that, parties involved will clearly defined their rights and liability against bonds and guarantee to assist the respective party in construction contract. 1.3 Objective of Topic The objective of the study is to identify legal principles used by the courts in granting or rejecting an application for injunction against bondsmen from making payment or against employer from receiving the bonds. The objective of the topic is spelt out through the analysis made on the common issues disputed throughout problem statement above. 1.4 Scope of Topic The examination is based on cases related to building contract and any circumstances arising thereof, in connection to the building contract. Beside that, the cases selected which decided from by Malaysian courts. However, there are frills with relevant cases from other jurisdiction.

1.5 Significance of Topic This study is hoped to give brief information on the bond application, management and its effectiveness in construction contract practice in order to be a reference to the Malaysian construction contract practice. Once they understand the basic principles, and realize their rights and liabilities in performance bond when the time of calling or receiving payment, the potential dispute might reduce. Beside that, it is significant if this study could identify the problems and recurring issues in court cases regarding bonds and guarantees in injunction relief to restrain the payment of bond and determining the principles involved in the court judgment. 1.6 Methodology and Research Process In order to fulfill all the objectives of this topic, the method that need to be taken had been recognized and planned. All methods have been divided into stages as assessment of this research as shown in Chart 1.1. Beside that, the research process on this report generally consists of four (4) stages, i.e. 1 st stage: Analysis of the problem, 2 nd stage: Identification of issues commonly in dispute, 3 rd stage: Finding of primary sources of relevant law and 4 th stage: In-depth examination of the individual cases to extract the relevant legal principles. 1.6.1 Problem Analysis As a necessary precondition, the basic concepts relevant to the study had to be understood. This understanding was acquired from textbooks, journals or any printed

sources. The subject of guarantees and bonds is still very specialized. Good understandings of the basic concepts to be used to refer to specific aspects were examined. The terms available in such as contract, guarantee, bond, performance guarantees, performance bond, security, performance security, banking, suretyship, and construction law. The information and data of this research will be obtained and collected from the analysis. Mostly the research will exercise the resources from two (2) basic types of sources. There are: 1.6.1.1 Primary Data Primary data collected mainly from Malayan Law Journal, Singapore Law Report, Building Law Report, Construction Law Report and other law journals. It is collected through the LexisNexis law database. All the cases relating to the research topic will be collected in order to identify the problems and the recurring issues related to bonds and guarantees in Malaysia and overseas construction contracts. 1.6.1.2. Secondary data Secondary research data will be retrieved from the books, standard form of building contract, articles and journals, seminars papers as well as Internet websites. These sources are important to complete the literature review chapter.

All the data that have been obtained will be systematically analyzed, interpreted, arranged and write up. 1.6.2 Identification of Disputed Issues The present stage was essentially a formalization of the issue identification process through references to relevant law reports and articles in journals. The use of indexes of legal journals and law reports ensured the identification of every relevant case and article. The issues most commonly raised in litigation have two main sources. The first concerns the interpretation of the particular instrument, i.e., the nature and extent of the obligations undertaken by the bondsman or surety, whereas the second is about the circumstances in which a court may restrain a claim on the instrument or dealing with the proceeds of a successful claim. 1.6.3 Identification of Relevant Case Law The outcome of the earlier stages was identification of the relevant questions and the establishment of trails of the law on each issue in the form of some relevant cases. Citatory were used to identify subsequent cases in which each case already identified was affirmed, applied, approved, considered, disapproved, distinguished, doubted, explained, extended, followed, not followed, overruled, referred to, or reversed.

1.6.4 In-depth examination of the individual cases to extract the relevant legal principles. Then, each case examined to extract the relevant legal principles accordance to the objective of this report. It mainly involves analyzing and writing.

PRELIMINARY RESEARCH RESEARCH PROPOSAL FINAL DRAFT OF RESEARCH PROPOSAL PRELIMINARY DISCUSSION WITH SUPERVISOR LIBRARY AND PUBLISHED Or printed articles IDENTIFIED RELATED CASES INTENSIVE DISCUSSION WITH SUPERVISOR DATA GATHERING PRIMARY DATA Legal cases from website SECONDARY DATA books, journal, magazines, or other ANALYSIS OF DATA WRITING OF FINDINGS CONCLUSION & RECOMMENDATION Chart 1.1. Flow Chart of Methodology

1.7 Terminology The following terms used frequently in this project report. Therefore, to preventing any misunderstanding and give benefit to non-legal readers, terminology is helping. 1.7.1 Surety 189 Webster s Dictionary defines surety as, The state of being sure; A pledge or other formal engagement given for the fulfillment of an undertaking; the one who has become legally liable for the debt, default, or failure in duty of another. The Surety Association of America (SAA) has defined a surety bond as, An agreement providing for monetary compensation should there be a failure to perform specified acts within a stated period. 1.7.2 Guarantees 190 A guarantee has been defined as an accessory contract by which the promisor (the guarantor) undertakes to be answerable to the promisee (the creditor) for the debt, default, or miscarriage of another person (the debtor), whose primary liability must exist or be contemplated (Halsbury s 1993). 189 Roozbeh Kangari. & Moataz Bakheet. (2001). Construction Surety Bonding. Journal Of Construction Engineering And Management. 127(3): 232-238 190 Ibid, Footnote 18.

1.7.3 Bonds 191 A bond is a promise by deed by one party to pay another a sum of money. A guarantee executed as a deed in which the guarantor undertakes to answer for the debt, default, or miscarriage of another by a monetary payment is therefore a bond. The bond may make payment unconditional, i.e., payment must be made on a demand by the promise or it could be conditional on defined events. The former type are referred to as a first conditional bond or an on demand bond, whereas the latter type is called a conditional bond. In practice, a conditional bond is commonly referred to as a guarantee or performance guarantee, whereas the terms performance bond or even just bond is reversed for unconditional bonds. 1.7.4 Synonymous Title of Parties Involved 192 1. Guarantor, Surety, Bondsman, Obligor, (and in the case of some on demand or letter of credit situations Bank or Issuing bank. 2. (principal) Creditor, Obligee, and, in some on demand situations, Beneficiary (who in the case of performance as opposed to payment bonds will normally be the construction owner, or in the case of some subcontracts the employing main contractor). 3. (principal) Debtor, Principal, that is, the party whose obligation is guarantees, in performance bond, this will be the contractor or subcontractor. 191 Ibid, Footnote 18. 192 Wallace, I.N.D. (1995). Hudson s Building and Engineering Contracts: Including the Duties and Liabilites of Architects, Engineers and Surveyors. 11 th Edition. Vol. 2. London: Sweet & Maxwell Limited.

CHAPTER 2

CHAPTER 2 PERFORMANCE BOND 1.2 Introduction Most construction contractors are familiar with the process of obtaining surety bonds, but they may not be aware of the legal relationships which establish among the principal (the contractor), the obligee (usually the owner) and the surety. On the other hand, the contractor s lawyers are aware of the rights and the obligations of the principal, obligee, and surety, but they may lack practical knowledge about the process of obtaining bonds. 193 This lacking of understanding will convey to the dispute especially when the time for calling the bond. 193 Donohue and Thomas, A. (1996). Construction Surety Bonds in Plain English. New York: Federal Publications.

Therefore, in this chapter examines surety bonds that are used in construction industry specially, performance bond. From this examination, there are determinations on the nature of performance bond, the types, construction of the instrument, and the practice of calling the bonds. Accordingly, the framework will give general idea of the performance bond which will be incorporated to the next chapter that observed on injunction relief in performance bond. 1.3 Surety Bond in Construction Contracts. Construction contracts are those that are entered into by employees and contractors for the purpose of performing and completing construction projects. 194 On the one hand, when contractors enter into such contracts they extremely agree to accept two main responsibilities such as to complete the works 195 and to pay all costs associated with the work. 196 On the other hand, employees may require contractors to provide security of performance of those obligations in the form of surety bond. 197 A construction surety bond is a financial instrument used generally when the first party (owner) has an agreement with a second party (construction company). This financial instrument serves as a guarantee to the first party from a third party (surety company) that a construction job (obligation) will be completed according to the terms and conditions within a written contract. 198 Therefore, the bonds are fundamentally credit risks, the surety party will do well to consider in advance the principal s financial status 194 Roozbeh Kangari. & Moataz Bakheet. (2001). Construction Surety Bonding. Journal Of Construction Engineering And Management. 127(3): 232-238 195 Clough, R.H., Sears, G.A. and Sears, S. K. (2005). Construction Contracting: A Practical Guide to Company Management. New Jersey: John Wiley & Sons, Inc. 196 Ibid, Footnote 26. 197 Sweet, J. (2000). Legal Aspects of Architecture, Engineering and the Construction Process. 6 th Edition. United State of America: Brooks/Cole Publishing Company 198 Ibid, Footnote 27.